What is an Idiosyncratic Whisk?

In financial theory, idiosyncratic risk is the risk that is specific to any given security. Since it is possible to diversify all risks that are not correlated to the broadly diversified market, financial theory would predict that you cannot earn profits by taking on idiosyncratic risk - you can only profit from exposure to undiversifiable risk.

I mentioned that I might someday start a hedge fund called the "Idiosyncratic Risk Fund" to a professor that I admire. He told me that I'd be laughed out of the industry. Of course he was right. But, of course, that is what I am doing.

Financial theorists look at the full range of investing opportunities, and rightly conclude that the securities with excessive specific risks do not, on average, produce higher returns. But, for the speculator, if the good eggs can be separated from the bad eggs, these are the types of securities that will amplify the results of your work, good or bad.

Of course, markets are generally very efficient. For example, there are thousands of bonds and bond derivatives that trade every day, moving by the minute. Their prices are all interlinked by a broad set of factors related to time, inflation, credit risk, etc. Yet, it is nearly impossible to find a sufficiently mispriced security in this teeming throng of moving prices to make arbitrage excessively profitable.

The image of the idiosyncratic whisk brought to my mind what the theorist might see - the broad set of investable securities as a giant bowl of scrambled eggs. The speculator takes each bowl, one by one, and says, most of the time, "Yep, scrambled." "Yep, scrambled." "Yep, scrambled." But, with much discipline and a clear eye, occasionally, you can stick the whisk in and say, "Hmm, lookie here. A yolk."